Stock market. Reality check: Dividend yield stocks don’t beat markets

Income flow from consistent dividends make dividend yield stocks popular with investors. However, these stocks underperform the markets even when considered on a total return basis, shows an analysis. While dividends may be attractive, what should matter to an investor is the total return of a stock. Total return captures the return for a stock resulting from price increase or decrease as well as dividends considered reinvested in the stock.

For this analysis, we go back five years in time to June 2016 and look at the performance of top 20 stocks by dividend yield (excluding special dividends/other one-offs) then. It shows that if you had bought a basket of the high dividend-paying stocks in 2016 and held them until now — five years being a reasonably good timeframe for equity market to go through ups and downs and deliver — your chances of having made market-beating returns are quite low.

Trailing the market

Seventy-five per cent of the top 20 dividend yield stocks have underperformed the Nifty 500 TRI (total return index) return of 111 per cent since June 2016 till date. The five-year total return for these 15 stocks has ranged from minus 49 per cent to 93 per cent. Among the stocks that eked out returns, the biggest laggards were ONGC (8 per cent), Gujarat Mineral Development Corporation (24 per cent), NLC India (27 per cent), Greaves Cotton and GE Shipping (both 39 per cent each).

Worse, despite the dividends, investors would have lost money in Indiabulls Housing Finance, IFCI, Coal India, NBCC India and Welspun India in the last five years.

Only five high dividend yield stocks — Sonata Software, REC, NMDC, National Aluminium Company (NALCO) and VST Industries — managed to outperform the broader market. These stocks generated total returns in the range of 143 per cent to 449 per cent. Sonata Software was the top performer, though a swift movement in the stock price has happened only since last year.

Worth the risk?

Equities are supposed to give returns that not just beat interest rates, but also compensate for the risks that an investor takes for choosing it as an asset class. From that perspective, the basket of dividend yield stocks doesn’t score well.

Investing an equal sum of money across the top 20 high dividend yield stocks in June 2016 would have today fetched you a total return (CAGR) of 10.5 per cent. If you had skipped investing in just one stock, Sonata Software, your total return (CAGR) would have been significantly lower at 7.5 per cent.

Alternatively, if you had invested the same sum in a cumulative 5-year fixed deposit of any of the leading banks offering 7- 7.5 per cent (approximately) per annum in June 2016, your effective yield would have been the same with annual compounding and higher, with quarterly compounding.

Thus, careful stock-picking of dividend yield stocks could make all the difference to your returns. To be sure, instead of plainly going by high dividend yields, investors need to analyse whether the high dividend yield of the stock is because of market price fall. If the business of such companies faces challenges, the high yield could be a consequence of the stock price reflecting these concerns. For example, in the list from 2016, 13 out of the 20 stocks are PSUs. Of this, 10 have underperformed the broader market.

This is why actively managed dividend yield mutual funds, for instance, typically use dividend yield only as the first level filter to choose stocks. Potential for earnings growth as well as capital appreciation are equally important metrics that are considered.

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